January 5, 2001
Mr. Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549
Re: Securities and Exchange Commission File No. SR-NASD-99-65
Dear Mr. Katz:
Instinet Fixed Income Inc. ("IFI") welcomes this opportunity to offer its comments to the Securities and Exchange Commission (the "Commission") on Amendment Nos. 2 and 3 to the National Association of Securities Dealers (the "NASD") proposal to create a corporate bond trade reporting and transaction dissemination facility and to eliminate the Nasdaq Stock Market's ("Nasdaq") Fixed Income Pricing System.1 IFI is deeply interested in bond market transparency. IFI operates an electronic fixed income trading system in the United States and Europe. This service, which began live trading in March 2000, provides subscribers with a more efficient way to trade fixed income securities. We believe it will contribute to more transparent and more liquid fixed income markets as well. IFI is a subsidiary of Instinet Corporation,2 a leading electronic global agency broker for equities.
This letter supplements our prior comment letter on this proposal, which we incorporate by reference.3 In our prior letter, we expressed three central concerns with the proposal:
The revisions contained in Amendment Nos. 2 and 3 do not address any of these central concerns. No improvement has been made to the mandatory transaction reporting aspect of the proposal. The proposal still contemplates that the NASD's Trade Reporting and Comparison Entry Service ("TRACE") would be the exclusive system for corporate bond transaction reporting, that all broker-dealers would be required to submit this debt market data to the NASD, and that the NASD would have exclusive enjoyment of whatever revenues are generated.
In fact, Amendment No. 2 increases the quantity of market information that broker-dealers would be required to report to the NASD. In addition to the categories of information that were required to be reported under the original proposal, including the identity and number of bonds, the price of the transaction, and the stated commission, broker-dealers would also be required to report "yield as required by SEC Rule 10b-10."4 Furthermore, broker-dealers would be required to provide the NASD the same transaction information that they provide to their clearing agencies.5 They would be required to provide this information within the same time frame and in the same format to the extent possible.
IFI therefore continues strongly to oppose the NASD's proposal. In our view, it would have a significant anticompetitive impact on the corporate bond marketplace. The key objective of securities market regulation should be to ensure that U.S. investors and securities markets continue to obtain the benefit of competition: new technologies, new services and lower costs. Establishing TRACE as a single, mandatory source of fixed income transaction reporting would stifle rather than promote competition. The Commission and NASD should instead strive to ensure that the forces of competition provide information to investors efficiently.
II. Specific Concerns with the Proposal as Amended
A. Moving Ownership Of TRACE From Nasdaq To NASD
Does Not Address Concerns About Fair Competition:
As described above, IFI criticized the original NASD proposal as an inappropriate use of the NASD's rulemaking authority as a self-regulatory organization to benefit Nasdaq at the expense of competing systems operated by NASD members. In IFI's view, Nasdaq's investments in the Optimark and Primex trading systems and proposed "SuperMontage" order display and matching facility are additional examples of this disturbing trend.6 We noted that Nasdaq's plans to change its governance structure to a for-profit shareholder-owned corporation, a process that is well underway, only exacerbates this conflict of interest.
As the Release notes, with some understatement, "[m]any commenters expressed concern about...the roles and responsibilities of NASD and Nasdaq in this initiative."7 In response to the concerns expressed by IFI and others, Amendment No. 2 clarifies that "NASD is the owner and operator of the facility, TRACE..." and that "NASD will file an application with the SEC to become registered as an exclusive securities information processor (ESIP) under Section 11A of the Act."8 The NASD "represents that it will exercise full ownership and operational control over the TRACE project, including day-to-day administration [of] the information collection process."9
In the next breath, the NASD belies its assertion that it will exercise operational control over TRACE. The NASD "represents that it will be able to employ Nasdaq as its vendor of information processing services."10 The NASD seemingly must contract with someone to provide these services as it has no experience or expertise in data consolidation. There is no indication in the proposal that Nasdaq would face any competition before receiving the contract to perform these services. In fact, the NASD rejects out of hand the possibility that any entity other than the NASD or Nasdaq collect fixed income transaction information: "the NASD believes that it is the SRO most appropriately situated to undertake this regulatory initiative."11
Congress has stated that an exclusive securities information processor must "function in a manner which is absolutely neutral with respect to all market centers, all market makers, and all private firms."12 In IFI's view, a truly independent and neutral exclusive SIP for the fixed income market would exhibit certain characteristics. Ownership of the exclusive SIP facilities would be broadly shared among market centers. Alternatively, the exclusive SIP facilities could be owned by a technology provider chosen through a competitive bidding process and not affiliated with any market center. All market centers trading fixed income securities would have a role in the governance of the exclusive SIP. SIP governance could also include participation from market data vendors, order entry firms, and the public. Market centers would share fairly in the revenues generated by the sale of consolidated debt market information.
Placing nominal ownership of TRACE in the NASD while Nasdaq designs and operates the system does not address the concerns about fair competition raised by the original proposal. Not only does the NASD have a continuing share ownership in the Nasdaq marketplace, it does not contemplate a full separation of itself and Nasdaq even after the "privatization" of Nasdaq is complete. With the TRACE systems designed and operated by Nasdaq, there is every likelihood that Nasdaq will use its role as information processor to favor itself as an execution venue in the corporate bond market. Such an arrangement will not satisfy the Congressional mandate that an exclusive SIP be "absolutely neutral with respect to all market centers."
Should the Commission determine to move forward on TRACE, certain minimum safeguards must be in place to ensure that Nasdaq's success or failure as a clearance, comparison or execution venue is determined by the interplay of market forces, not through use of regulatory authority. As noted above, Amendment No. 2 contemplates that broker-dealers would report to the NASD the same information they provide to their clearing agencies. To ensure that Nasdaq does not establish a de facto monopoly in this area, Nasdaq facilities used for processing fixed income market data must be strictly separate from any facility used for comparing or clearing trades. Any such facility must submit data to the processing facility on the same terms as any other market participant. Submission of data to the processor must not entail submission of trading interest to a Nasdaq facility. Finally, market participants must have a role in the governance of the exclusive SIP.
B. By Relying on a Single Exclusive SIP, Amendment No. 2
Does Not Address Concerns About Centralization:
Not only does the NASD dismiss any possibility that some other entity could act as the exclusive SIP for the fixed income market, it summarily rejects the notion that competition could play a role in the collection and dissemination of corporate bond transaction information. Some commentators urged the Commission to adopt a decentralized model for bond market information, with multiple entities collecting and disseminating such information.13 These commentators argued that this competition would spur innovation in this area.14 While paying lip service to the importance of competition, the NASD stressed that "other factors, such as equality of access, reasonableness of fees, and sufficient system capacity and security, are equally important."15 While the NASD apparently believes these factors are in some way in conflict with the notion of competition, it supplied no analysis to support such a conclusion.
In contrast, a significant body of opinion is coalescing around the view that competition in the consolidation and dissemination of market information may be the best way to ensure an accessible, reasonably priced and secure stream of market information. This view emphasizes the advances in information technology in recent years, including the explosive growth in the availability of computer processing capability; the creation of more rapid and continuous methods of communications among a broad range of market participants; and the development of standard communications protocols that allow the creation of network architectures on a scale nearly inconceivable twenty-five years ago.
At the same time that the NASD is proposing to extend its information monopoly from the equities market to the fixed income market, a thoughtful review is under way regarding whether that monopoly continues to make sense in the equities market. The Commission's Advisory Committee on Market Information is exploring "alternative models for disseminating and consolidating information from multiple markets" among other issues.16 The Advisory Committee's first meeting included "discussion of alternative models, including opening up the consolidation function to competition."17 Five separate proposals for introducing competition into the consolidation and dissemination of equity market information were subsequently submitted by Advisory Committee members.18 These proposals will be considered by the Advisory Committee in the course of its deliberations, as will proposals to improve the current model for consolidating and disseminating equity market information.
Whatever the wisdom in 1975 of awarding Nasdaq a monopoly over the dissemination and consolidation of equities market information, relying on a single provider creates risks that no longer need be tolerated with today's technology. Delays and outages at Nasdaq have become distressingly commonplace as trading volume has increased. As recently as this past month, Nasdaq has seen its quote engine rendered unavailable and announced a delay in implementation of its SuperSoes system.19 The Commission is well aware of Nasdaq's delays in implementation of decimal pricing, which need no recitation here.
Greater availability of accurate debt market information would promote investor confidence and market efficiency. Ultimately, this would lead to greater liquidity in the debt market. The NASD's proposal, however, seeks to advance these goals at the sake of innovation and competition. It would extend to the debt market the monopoly franchise enjoyed by Nasdaq over the sale of market data, at a time when the rationale for that monopoly franchise no longer exists even in the equity market.
The shortcomings of a model that creates a single point of failure for the entire market place are increasingly evident. Much thought is being put to the contours of alternative models that would allow greater scope for innovation and competition. IFI urges the Commission to allow its Advisory Committee on Market Information to complete its comprehensive review of market data issues, including in particular the benefits of competition in the consolidation and dissemination of data, before taking any action on the NASD's proposal. Rather than granting Nasdaq a lucrative monopoly over dissemination of debt market information, the Commission should allow the forces of competition and technology to shape the dissemination of debt market information. This will lead to greater quantities of information being made available to investors more quickly and cheaply.
* * * *
We would be pleased to discuss any of the comments in this letter with the Commission or its staff. If we can be of further assistance to the Commission in this regard, please do not hesitate to contact Peter Fenichel, President, IFI (212.310.7247) or myself (202.789.8550).
Senior Vice President
Government and Regulatory Affairs
cc: The Honorable Arthur Levitt, Chairman
The Honorable Isaac C. Hunt, Jr., Commissioner
The Honorable Paul R. Carey, Commissioner
The Honorable Laura Simone Unger, Commissioner
Annette L. Nazareth, Director, Division of Market Regulation
Robert L.D. Colby, Deputy Director, Division of Market Regulation,
and Senior Advisor to the Chairman
Belinda Blaine, Associate Director, Division of Market Regulation
Elizabeth K. King, Associate Director, Division of Market Regulation
Katherine A. England, Assistant Director, Division of Market Regulation
|1||Exchange Act Release No. 34-43616 (November 24, 2000) (the "Release").|
|2||Instinet, a member of 20 exchanges around the world, is a registered broker headquartered in New York City and has offices in eight international financial centers. Instinet is a pure agency broker, serving its global client base by consistently reducing transaction costs and thereby increasing investment performance for investors and their proxies.|
|3||See Letter from Peter Fenichel to Jonathan G. Katz, Secretary, SEC, dated April 4, 2000.|
|4||See Release at 16 (proposed NASD Rule 6230(c)(13)). In transactions between two NASD members, the broker-dealer representing the sell side must report this information. In transactions involving an NASD member and a non-member, the broker-dealer must report this information regardless of the side he represents.|
|5||See Release at 7 (proposed NASD Rule 6231(a)). The NASD members of both sides of a transaction in a TRACE-eligible security would be required to report this information.|
|6||See Exchange Act Release No. 43,514 (November 3, 2000), 65 Fed. Reg. 69,084 (November 15, 2000) ("SuperMontage" as amended through Amendment No. 8) and Instinet's December 6, 2000 comment letter.|
|7||Release at 10.|
|11||Id. at 11.|
|12||S. Rep. No. 94-75 at 11-12 (1975).|
|13||Release at 11.|
|16||SEC Press Release 2000-102, "SEC to Establish Advisory Committee on Market Information," July 25, 2000.|
|17||See Letter to Members of the SEC Advisory Committee on Market Information from Joel Seligman, Dean and Ethan A.H. Shepley University Professor, October 26, 2000.|
|18||See Letter to Mr. Joel Seligman from Robert G. Britz, Group Executive Vice President, New York Stock Exchange, December 1, 2000; Letter to Dean Joel Seligman from Thomas Glocer, Chief Executive, Reuters Information and Chief Executive Officer, Reuters America Inc., December 4, 2000; Memorandum to Dean Joel Seligman from Edward J. Nicoll, Chairman & CEO, Datek Online Holdings Corp., December 5, 2000; Letter to Dean Joel Seligman from Gerald Putnam, Chief Executive Officer, Archipelago, L.L.C., December 6, 2000; and Memorandum to Joel Seligman from Carrie Dwyer, Executive Vice President, Corporate Oversight, Charles Schwab & Co., Inc., regarding "A Framework for the Future," December 8, 2000.|
|19||See Nasdaq Quote Engine Outage, Nasdaq Head Trader Alert #200-92 (November 29, 2000); SuperSoes Implementation Postponed Until January 22, 2001, Nasdaq Head Trader Alert #2000-95).|